Keeping on the pounds

What 'no euro' means for investing in Britain

LOS ANGELES (CBS.MW) -- That the British are unlikely to give up their beloved pound and join the euro bloc anytime soon may be the worst-kept secret in Britain and Europe.

Britain has largely benefited from the fact its currency and monetary policy is separate from the rest of Europe. Sterling hasn't appreciated as much as the euro, making British exports more competitive in continental Europe, and the U.K. economy isn't hampered by a restrictive, one-size-fits-all monetary policy.

But not all of British business is happy about this. More than two dozen business leaders including the heads of Vodafone
VOD, -1.55%
and British Petroleum
BP, -0.55%
sent a letter to the Blair government recently warning that staying out of the eurozone could harm Britain's already weakened economy.

Still, it's widely assumed that British Chancellor of the Exchequer Gordon Brown, the equivalent of the U.S. Treasury Secretary, will tell Parliament in early June that Britain isn't ready to enter the eurozone.

While no official word has emerged, he's expected to say the U.K. hasn't passed his five, economic tests to measure the timing and impact of entry. These tests include sustainable convergence between Britain and the euro economies, and the effect euro entry would have on investment, but the criteria have been described as vague enough to keep the U.K. out indefinitely. See full story.

A bigger obstacle evidently is the British public itself, which must vote on the euro even if the government approves. Steven Bell, global chief economist with Deutsche Asset Management in London, said strain relations between Britain and eurozone leaders France and Germany in the wake of the Iraq war have made the British public even less amenable to change.

"We're an independent-minded people," Bell said. "The currency has had its ups and downs for hundreds of years, but we don't want to give it up."

Business as usual?

In Britain, financial markets have largely accepted that sterling will remain outside the euro for the foreseeable future. But U.S. investors may not notice the difference.

"Most of the equity market that Americans might buy are big companies that operate on a global playing field, such as Vodafone, BP and GlaxoSmithKline," Bell said.

If Britain stays out of the eurozone, British companies that export to Europe will likely get a boost from the fact that sterling hasn't appreciated as much as the euro. But few of these companies are publicly traded.

Potential beneficiaries include industrial companies like BOC Group (BOC), said Martin Schultz, director of international equity markets for Cleveland, Ohio-based Armada Funds. "With the current situation, I think the industrial companies, players that compete against European competitors, are going to be the ones to benefit -- like BOC Group. Selling into Europe is a boon to them.

Home grown and global gains

While Schulz is currently underweight investment in the U.K., citing concerns about the country's economic strength, he is finding value in the business service sector. Favorites include Vodafone, a holding of many fund managers, and outsourcing firm Capita Group
CAPGF
which does most of its business with the British government.

Concentrating U.K. exposure on companies that primarily serve the local economy has worked for funds like ICAP Euro Select Equity
ICEUX, -1.25%
a $23 million institutional fund. Its picks include the Royal Bank of Scotland, a local banking giant, which also has some U.S. exposure via Citizens Financial Group, a $64 billion bank holding company headquartered in Rhode Island, and Tesco
TSCDY, -1.42%
the country's largest retail food chain.

"It's been a lot easier to find names in the U.K. where the valuations are cheap, the end market is growing or stable, market share is good and circumstances where the management is stable," said Matthew Pickering, a research analyst for Chicago-based Institutional Capital, which oversees the ICAP funds.

Pickering likes the fact Britain's fiscal policy stances have been more appropriate than those on the Continent, and consumer spending has remained strong. "The valuations of the U.K. have been more attractive in many respects," he added. Plus, he said, Britain "has a history of paying out more excess profits and dividends than other countries."

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